Wednesday, September 24, 2014

GLICs And Capital Outflows

I’ve heard this from more than a few people (excerpt):

Mahathir expresses concerns on fund outflow

KUALA LUMPUR: Former Prime Minister Tun Mahathir Mohamad has expressed his concern over local funds, including the Employees Provident Fund (EPF) on their property investment overseas as it promoted fund outflow from the country. "At a certain extend it is desirable to invest abroad, but we should always have to balance between inflow against outflow of funds," he said…

…He pointed out that too much of fund outflow from the country would not be good for the economy, especially overseas property assets that were acquired.

"Instead of supporting local industry, they (funds) have gone abroad," he said….

…Meanwhile, he was also concerned about the 1Malaysia Development Bhd's (1MDB) plans to sell up to RM8.4bil of Islamic Bonds…

Of course, TDM’s word carries a lot more weight and credibility than most.

Nevertheless, I have to disagree with the sentiment. Let me clarify that a little bit – I disagree with everything he said except for the concern over 1MDB, which I think is a concern shared by nearly everyone I know. It’s one thing to leverage up to enhance returns, its another to skirt on the edge, because sometimes you go a little too far and fall off.

Be that as it may, to return to the issue of fund outflows by the GLICs, there’s actually a pretty sane reason for it and it goes back to the first fundamental of investing – don’t put your eggs in one basket.

Any first year finance major knows this – as much as you might be more comfortable investing in your own market, a portfolio of assets (where the return on those assets are not perfectly correlated with each other) will always yield a lower volatility of return (i.e. risk) than investment in a single asset. The same goes for an investment in a single sector, a single country, or a single stock. No matter how safe a particular investment looks, it’s pays to diversify in the long run.

Now most people will look askance at this, usually with dark mutterings of unpatriotism, but being accused of being unpatriotic is just another way of saying you gotta invest in an asset with lower risk adjusted returns. Not exactly rational, or calculated to get the best investment return. Just remember, the purpose of the GLICs (with the possible exception of Khazanah) is to serve the retirement needs of their members (EPF, KWAP, LTAT), or savings (PNB), or the Haj (LUTH). If that means going international, better learn to live with it.

Requiring the GLICs to confine their investment in Malaysia means taking on greater risk for lower expected returns. In the current environment, with relatively high foreign portfolio holdings in Malaysia, that simply means bidding up prices of local stocks and bonds, which reduces their return relative to their prices. Again, not exactly conducive to building those life savings. Malaysia’s equity market hasn’t been all that popular with foreign investors for some time – not because there aren’t good companies to invest in, but because valuations are too rich. Translation: prices (and risk) are a bit too high to justify the returns you get.

A second issue, which people appear to have totally missed, is that as high profile as the property purchases by EPF, PNB, KWAP et al have been, property remains a very small asset class for them. We’re talking maybe a collective 2%-3%, if not less. GLIC holdings of foreign stocks and bonds are much, much bigger and have been going on for longer than most people think they have. PNB for instance went foreign almost from the start (remember the Dawn Raid?), and have had a permanent international presence since the 1980s. The other GLICs have not been far behind.


  1. Isn't there a property glut or overhang in Malaysia, be it offices, residential property (especially the high-end), shopping malls etc?

    Is Tun Dr Mahathir suggesting that government-linked funds have a fiduciary or other duty to "prop up" the local property market and forego better returns elsewhere?

    What about the funds' responsibility to their shareholders to get the best possible return for their investments?

    And if we can't get our urban planning act together (Iskandar being a case in point), the government-linked funds should not be stepping in to mop up the consequences of haphazard or faulty urban planning.

    By all means, invest in infrastructure.

    But real estate in Malaysia......?

  2. With all due respect to Tun, I think everyone has given him too much respect. For sure, Tun talk for his own interest and no one else, same as all analyst.

    Thank you Hishamh, as always, clarity among all the gibberish/cloud/vested interests/yada....

    Zuo De

    1. @Zuo De,

      You haven't asked if I've got any vested interest in this :)

      But you're welcome just the same

    2. LOL.

      But in a little bit of seriousness....I might be a little bit sympathetic with TDM's view (not his rationale) and I'm saying this with a lot of bias from my workplace.

      Institutional funds are large, but in the bond market domestically, they confine themselves to the highly rated papers and so much so that there is virtually no liquidity from them in papers rated under AA3. This has prevented banks to participate in those bonds as well. It's probably right to assume that the probability of default may be higher (slightly!), but at the same time, wouldn't the positive externality be that it increases the bond market vibrancy and allow for greater sources of funding for the private sector? But yes, I get it...the ultimate objective is secure returns for the shareholders.

      Also, I'm a bit undivided with the view of having domestic savings channeled overseas. Yup, I can agree that Malaysia is externally resilient and can absorb some losses. But I think long-term gains (isn't that the objective for the institutional investors?) are limited...frankly, if our current account surpluses and FDI flows are persistent, shouldn't that argue for reduced FX gains on your investments?

      But again, I'm saying this with a lot of bias :)

    3. Hishamh,

      My apology. Did not include you in the sweeping statement. Have to be more careful next time.

      Back to the foreign investment - there is also the element of foreign exchange risk that complicate the whole venture. One maybe making good money on the investment vehicle but once the exchange does the other way, it may even be negative return. Maybe this is what Tun is saying.

      Zuo De

    4. @Jason

      Part of the problem is pricing. If the yield is already fairly representing credit risk, expanding institutional bond portfolios below AA might result in a mispricing of risk.

      But I know where you're coming from

    5. @Zuo De

      Oh, no need for apologies. In this instance, I'm not an unbiased commentator. Probably should have put a disclaimer in the post.

  3. If you read carefully .what the Old Mannis saying is too much outflow is not good.

    the gist is balance in investing abroad.

    dr muzaffar

    1. How do you define "too much outflow"?

      Who decides what constitutes "too much outflow"?

      Politicians? Ex-politicians?

      Puhleese..... (pardon the vernacular)